May 16 (Bloomberg) -- Royal Bank of Canada, Bank of Nova
Scotia and six other large Canadian lenders are trading at the
lowest premium to U.S. bank stocks in more than two years, as
their American counterparts regain the confidence of investors.

“Canadian banks’ conservatism and sleepiness is not going
to be rewarded to the same degree as it has in the past,” John
Aiken, a Toronto-based analyst with Barclays Plc, said in a May
8 phone interview. “We’re back in an environment where earnings
growth trumps everything else, and the Canadian banks are going
to lag over the next year or so.”

As Canadian lenders prepare to report second-quarter
results starting with Toronto-Dominion Bank on May 23, the
spread between the Standard & Poor’s/TSX Commercial Banks Index
and the KBW Bank Index of 24 U.S. banks is at its narrowest
since January 2011, based on price to tangible book value per
share, according to data compiled by Bloomberg.

By that measure, Canadian banks are now less than twice as
expensive as U.S. banks, trading at about 2.49 times versus 1.41
times for the U.S. group, the data show as of yesterday’s close.
In October 2011, they were about three times more expensive, at
about 2.58 times versus 0.88 for U.S. banks.

Price to tangible book value measures what investors are
willing to pay for a company’s equity after removing intangible
items such as goodwill and brand names that would have little
value if the company went out of business.

No Bargain

Canada’s banks index has been little changed this year,
lagging the 17 percent rise of the KBW Index. Canadian lenders
are still no bargain when compared to global peers, according to
Franklin Templeton Investment’s David Tuttle.

“We’re looking for stocks mired in pessimism,” Tuttle, a
research analyst at Templeton Global Equity Group, which manages
$105 billion in assets, said in a May 10 interview. “Canadian
banks -- despite valuations coming off a little bit -- just
don’t demonstrate those characteristics of a stock that’s out of
favor.”

Spokesmen at Canada’s six biggest banks declined to
comment.

Canadian banks, ranked the world’s soundest for the past
five years by the Geneva-based World Economic Forum, are facing
a slowdown in domestic consumer lending as the housing market
cools and Canadians are urged to curb borrowing.

Household Debt

Household debt rose to a record 165 percent of disposable
income at the end of last year, according to Statistics Canada.
The International Monetary Fund last month cut its 2013 growth
forecast for Canada to 1.5 percent, the slowest among Group of
20 countries outside Europe and down from a 2 percent estimate
in October.

Canadian banks have about C$518 billion ($508 billion) in
insured residential mortgages and home-equity credit lines,
mostly backed by Canada Mortgage & Housing Corp., the nation’s
housing agency, John Reucassel, a BMO Capital Markets analyst,
said in a May 10 note. In a severe housing downturn, banks may
need to either recapitalize CMHC or absorb some potential losses
on insured mortgages.

Canada’s banking regulator is reviewing its guidance to
lenders on mortgages of more than 25 years. The Office of the
Superintendent of Financial Institutions is consulting with
banks on the risks posed given housing prices and rising debt
levels, said Brock Kruger, a spokesman for the regulator.

Mortgage Rules

Canadian Finance Minister Jim Flaherty has tightened
mortgage rules four times in the past five years amid concerns
that some regional housing markets were overheating. In July, he
reduced the maximum amortization period on mortgages the
government insures to 25 years from 30 years.

The country’s banks will grow adjusted per-share earnings
by 3 percent this year and 6 percent in 2014, Andre-Philippe
Hardy, an analyst at Royal Bank, said in a May 3 note. That’s at
the low end of growth rates experienced in past periods of
economic recovery and below the 8 percent to 15 percent growth
rates of 2010 to 2012, he said.

The gap between Canadian and U.S. banks narrowed because
investors became more confident about the real estate assets
held by American banks as U.S. housing improves, while getting
skittish on Canadian banks’ exposure to a slowing domestic
housing market, said David Baskin, president of Baskin Financial
Services Inc. He expects the gap to continue to narrow, though
investors can benefit by holding both.

“The positive on the Canadian banks is that people are
overstating the housing problems and therefore undervaluing the
earnings,” Baskin, whose Toronto-based firm oversees C$500
million, said in a May 10 phone interview. “The positive on the
U.S. banks is that their assets are better than people
thought.”

Short Sellers

Fund managers including Toronto-based Friedberg Mercantile
Group Ltd. are shorting Canadian banks on concern the housing
market will collapse. Emrys Partners LP founder Steve Eisman,
who rose to fame betting against U.S. subprime mortgages, said
at the Sohn Investment Conference in New York on May 8 that he’s
pessimistic about Canada’s housing market, saying rising prices
weren’t accompanied by growth in personal incomes.

Canadian home prices over the past 10 years have increased
by 83 percent, according to the Teranet-National Bank Home Price
Index. That outpaced the 34.3 percent increase in the average
weekly wage for full-time employees in that period, according to
Statistics Canada.

‘Dirt Cheap’

Investors had a short interest in 3.45 percent of the
Canadian bank shares available to the public as of April 30,
according to data compiled by Bloomberg. That’s the highest in
at least 10 months and above the 2.35 percent at the end of last
year. Short sellers profit from price declines by selling
borrowed securities and replacing them with stock bought at
cheaper levels.

Canadian investors such as Baskin still see a deal when
considering dividend yields and share price to future earnings.

Canada’s six-biggest banks will report a 4.2 percent rise
in per-share profit excluding some items in the second quarter
compared with a year earlier, according to Barclays’s Aiken.

Toronto-Dominion Bank, the second-largest lender by assets,
will increase adjusted profit by 4.7 percent to C$1.91 a share
when it reports, according to the average estimate of 13
analysts surveyed by Bloomberg.

National Bank

National Bank of Canada, the sixth-largest lender, will
increase per-share profit by 1.2 percent to C$1.97 a share when
it reports May 24, according to the average estimate of 12
analysts. The Montreal-based bank may raise its quarterly
dividend by 4.8 percent to 87 cents, according to Bloomberg’s
Dividend Forecast.

Scotiabank, the third-largest lender, is estimated to have
profit of C$1.26 a share, a 6.7 percent increase from the year-earlier period, when it reports May 28. Bank of Montreal’s
profit is estimated to climb 2.4 percent to C$1.48 a share when
it reports May 29.

Royal Bank, the largest lender, and Canadian Imperial Bank
of Commerce, the fifth-biggest, report earnings on May 30. Royal
Bank’s profit is estimated to jump 12 percent to C$1.31 a share,
and CIBC’s profit will rise 3.2 percent to C$2.06 a share,
according to analysts’ estimates.